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Airlines facing carbon risks

Air transport, often criticized for its significant CO2-emissions, will be soon (2012) integrated in the mechanism of the European Emission Trading Scheme. Before discussing in a forthcoming article the consequences of this decision for the aviation sector, we propose to make an inventory of the CO2-emissions.

We'll see that beyond the cost of fuel, a new element, the carbon risk, must be taken into account by the airline companies.

How much CO2 do airplanes reject?

To fix ideas, it is estimated that for equal distance covered, a person taking the plane for a long-haul flight consumes almost the same as by car. This calculation takes into account the occupancy rate of the aircraft and the average number of people in a car. Nevertheless, in reality, the car only competes with the plane for short-haul flights, for which the plane is far more polluting. This is due to the consumption of take-off and landing.

Figure 1: Evolution of the CO2-emissions by transport type and by passenger-KmNote: The fuel consumption for freight transportation in the baggage hold (significantly over the long-haul) is here assigned to passenger
Source: According to data from the DGAC (Direction Générale del'Aviation Civile), France

It is widely accepted that aviation contributes about 2% of global anthropogenic emissions of CO2. This relatively low figure is often put forward by airlines to reject regulations aimed at reducing their emissions. However, this value of 2% should be discussed.

What is the impact of an aircraft on climate?

First, the figure of 2% only takes into account the impact of CO2- emissions. However, the devices also emit ozone, soot, sulfates and slipstreams, which aggravate the greenhouse effect. The fact that the gases are released at high altitude must also be taken into account. Thus, the climate impact of aircraft is much higher than that of CO2 alone. Consequently, according to the IPCC, commercial aviation would amount to 3.5% of global warming due to human activities. This calculation does not take into account the action, still poorly understood, of aircrafts on cirrus cloudiness. Aircrafts are suspected of promoting the formation of these high clouds that also contribute to global warming.

Let's add that the emissions of the aviation sector are rising fast. According to the IEA, CO2-emissions related to the fuel consumption of this sector increased by 87% since 1990. This increase is mainly due to traffic growth, estimated at 50% since 10 years by the IFP. Though, technical advances aimed at reducing consumption of devices are undeniable: according to Airbus, a new generation aircraft like the A319 consumes 20% less than equipment delivered in 1980 and 40% less than an old generation devices. But these improvements are insufficient to offset the development of the sector.

Moreover, the trend should continue: The IPCC report of 2007 foresees an increase of 3 to 4% per year of emissions coming from the aviation sector.

An economic model in danger

Obviously, this situation constitutes a risk for airlines. Kerosene is a major cost item. It was, for a long time, stabilized between 10 and 14% of the total costs of a company because the rising fuel prices were counterbalanced by less and less consuming devices. Note that this percentage varies greatly from one company to another: it is much higher (up to 10 points) for low-cost airlines, which have reduced other cost items.

But this percentage is, in recent years, increasing. It was estimated at 18% in 2004 by Airbus. "Globally, oil, given the quality of our hedges, represents approximately 21-23% of our operating costs, but if we argue on fuel costs before hedging, this percentage would have been very close to 30%" , explained in 2008 Philippe Calavia, CFO of Air France-KLM.

Thus, companies are exposed to the fuel price risk, for which they are covered by long term supply-contracts. They recently also are exposed to carbon risk, i.e. the risk that environmental measures being taken to reduce emissions of greenhouse gases (GHGs) cause a high price per ton of CO2 emitted.

Exposure rate to carbon risk

To measure this risk (not only in the airline industry), the rate of exposure to carbon risk has been created. This indicator is defined as the amount of GHG emissions (tons of CO2 equivalent (t eq. CO2)) to generate a net income of 1,000 Euros. For air transport, the exposure rate is in the order of tens of t eq. CO2 k €. This value is given for information but the rates of exposure to carbon risk are really meaningful when applied to a particular company because of the very varied situations. In practice, this figure means that if a ton of CO2 emitted by airlines is valued at 15 Euros, a company must pay 150 Euros "tax" for 1000 Euros of net income, an aspiration of 15%.

This calculation is only valid in the case of the introduction of a carbon tax, a solution still under review at European level. Regarding the aviation sector, the chosen mechanism in Europe is the integration in the system of emissions trading scheme which will become effective in 2012. Only tons of CO2 beyond the allocated quota must be purchased on a carbon market, which severely limits the impact to the company. Indeed, quotas are usually very close to the observed emissions and only impose a slight decrease in emissions. The bill can still be cumbersome: the mechanism of the European CO2- emissions allowances would cost around 1 billion Euros per year for airlines. The risk is thus highly dependent on carbon regulations decided at the political level.